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Bristol Water – Response to 2019/20 Data for Base Cost Models – Working Paper

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Bristol Water – Response to 2019/20 Data for Base Cost Models – Working Paper BRISTOL WATER – RESPONSE TO 2019/20 DATA FOR BASE COST MODELS – WORKING PAPER Response to 2019/20 data for base cost models – working paper 1.1 Summary 1. In its working paper, the CMA is proposing to adopt an unjustified position that is not evidenced in relation to the base cost models. The CMA is proposing not to use the most recent data it has available, despite there being no conclusive evidence that there are issues with the data. 2. We can find no compelling reason why a rational and unbiased assessment would omit the 2019/20 water cost data from the modelling. In particular: • The amount that costs increased in 2019/20 was below the AMP6 trend, which undermines the assertion that costs in 2019/20 were atypically high. • Including the latest data does not reduce the statistical performance of the models. Indeed, one of the model coefficients becomes statistically significant with the inclusion of the data. • The potential examples of companies that have brought base costs forward are speculative, with not a single robust case of water service base expenditure definitely being brought forward from AMP7. • While it is possible that some companies may have brought forward some small amount of expenditure to 2019/20 from AMP7, the CMA has ignored the fact that its models include data from 2014/15, the last year of AMP5. It has provided no assessment of whether a similar phenomenon happened in 2014/15. • In setting performance targets the CMA considered outturn service levels for 2019/20. By considering the performance but not the costs, the CMA is creating a further disconnect between costs and service levels. 3. We also note that the CMA has not performed any cross-checks on the results of including the data. Including the 2019/20 cost data would bring the CMA’s cost estimates more in line with the extensive body of evidence we considered when developing our business plan and which we presented in our Statement of Case. 4. In the 2015 re-determination, the CMA considered using the latest data, but only chose not to once it was shown not to make a material difference to cost allowances. For this re-determination, no sensitivity testing was apparent for this paper. 5. If the CMA proceeds on the basis set out in the consultation paper, we have serious concerns that the Final Determination will not achieve the correct balance of the statutory duties which apply to the CMA. In particular, including 2019/20 data when setting performance targets, while at the same time excluding 2019/20 cost data when setting base cost allowances would be an inconsistent approach contrary to the overarching duty to have regard to the principles of best regulatory practice. These principles importantly include a requirement for regulatory decisions to be consistent.1 1 Section 2(4) WIA91 1 CEC-#27996119-v1 BRISTOL WATER – RESPONSE TO 2019/20 DATA FOR BASE COST MODELS – WORKING PAPER 6. Furthermore, a decision not to include 2019/20 cost data when setting cost allowances would entrench a situation whereby Bristol Water is underfunded to deliver its service performance targets in AMP7. Given the existing financeability challenge which we evidenced in our Statement of Case and supporting submissions, if the CMA were to leave our service performance targets underfunded as proposed, that would represent a breach of the Finance Duty. 7. In summary, the proposed position in the working paper is fundamentally flawed. We urge the CMA to take what should be a non-contentious decision to include the latest data in its final determinations. 2 CEC-#27996119-v1 BRISTOL WATER – RESPONSE TO 2019/20 DATA FOR BASE COST MODELS – WORKING PAPER 1.2 Biased approach 8. In the working paper, the CMA explicitly recognised that there are advantages of including 2019/20 cost data. However, the CMA decided not to include the 2019/20 cost data, as it chose to place particular weight on the risk of biasing its predicted allowance of base costs by including in cost models investments brought forward by companies from AMP7. 9. We have consistently argued that Ofwat’s overall approach to cost assessment is biased towards producing allowances which are lower than required, and hence erroneous. This includes Ofwat’s interpretation of 2019/20 water service base costs, and whether this is representative of the level of service, or some other factor. 10. In our business plan, we considered a wide-range of evidence based on both top-down and bottom-up approaches. Our bottom-up approach led us to adopting a cost position towards the lower end of the range implied from the top-down modelling (i.e. it was more stretching). Further details of how we developed our plan are included in Annex 7 of our Statement of Case. 11. The CMA has not engaged with our evidence base, and instead solely used Ofwat’s approach as its basis for determining costs. The fact that Ofwat’s modelling approach resulted in a materially lower cost allowance (contrary to the substantial body of evidence we provided) strongly suggests that the Ofwat framework is flawed. 12. As set out in Paragraph 179 of our Response to CMA Provisional Findings2, including the 2019/20 cost data in the models closes a material part of the gap between our assessment of costs and the cost estimate obtained from using Ofwat’s approach (with the remaining gap closed by other cost issues such as leakage) – i.e. it brings the CMA’s results closer to the results obtained from other approaches3. Therefore, omitting this data does not avoid bias, it allows the existing bias to persist. 13. The CMA has performed no form of cross-check against other approaches to determine whether Ofwat’s models including the 2019/20 data produce more appropriate results than without. Instead, the CMA has simply assumed that Ofwat’s approach is unbiased without the most recent data. Not testing the results nor testing the sensitivity of the inclusion on totex allowances, is fundamentally flawed. 14. The CMA states that “Biased predicted allowances risk consumers overpaying or underpaying for water services. Our provisional view is that this is a high risk in comparison to the benefits 2019/20 cost data would provide”.4 This suggests that the CMA views underfunding companies as being less detrimental than overfunding. Underfunding companies is not consistent with the CMA’s Finance Duty. We have totex sharing rates proposed by the CMA which are asymmetric, and underfunding is not something supported by customers. The CMA’s provisional view also relies on a false premise, namely that incorporating 2019/20 cost data risks under- or over-funding companies, whereas excluding that data raises no such risks. In fact, having set service levels based on 2019/20 performance data, excluding cost data from the same period when setting base allowances risks companies being under-funded, the very thing which the CMA states it is seeking to avoid. 2 This data has been superseded by the model data set provided by Ofwat following APR queries, as we recognised in our response to RFI25, Q5. 3 Bristol Water Statement of Case, paragraph 332 4 CMA (2021), ‘2019/20 data for base cost models – Working Paper’, paragraph 64. 3 CEC-#27996119-v1 BRISTOL WATER – RESPONSE TO 2019/20 DATA FOR BASE COST MODELS – WORKING PAPER 15. Making use of the most recent information is well established in terms of regulatory precedent. In the 2015 re-determination, the CMA considered the most recent data, and only decided not to reflect the data in its models due to the fact it did not have a significant effect on the modelling suite at the time.5 Contrary to the position in the CMA’s PR14 redetermination, the exclusion of 2019/20 cost data has a significant impact on cost allowances for AMP7, and accordingly proposals to exclude this data from modelling on the basis of supposed distortionary effects should face a high evidentiary bar. 16. In its Provisional Findings for this re-determination, the CMA stated “when taking decisions regarding the determination, we should use the most up to date information available”.6 We also note that the CMA has used service performance data from 2019/20 in its provisional findings to justify setting stretching performance targets for the companies. When justifying its provisional decision to exclude 2019/20 cost data from the base cost models, the CMA notes that its ‘Approach to the redeterminations’ document made clear that “[the CMA] will also consider whether information is complete and robust so that we can place reliance on it”.7 2019/20 costs data has already been subjected to Ofwat’s quality assurance process, and this should be sufficient grounds for the CMA to conclude that the data is “complete and robust”. 17. There are two points of principle that we consider should apply to any rational and unbiased assessment of base cost allowances: • using the most up to date information should be a regulatory authority’s first preference; and • increasing the number of observations should increase the accuracy of the coefficient estimates. 18. These positions should only be deviated from if there is compelling evidence of data issues. Such evidence has not been provided, and we do not believe that such issues are present in this data. We provide further detail in the next section on how there is insufficient evidence to determine that companies have ‘brought forward’ an atypical level of expenditure. 19. The CMA states that it is concerned that the 2019/20 could distort its cost estimates. If the 2019/20 data was distortive, we would expect to see a deterioration in model performance.
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